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Downside Loss Aversion and Portfolio Management

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Author Info

  • Robert Jarrow

    ()
    (Johnson Graduate School of Management, Cornell University, Ithaca, New York 14853)

  • Feng Zhao

    ()
    (Rutgers Business School, Rutgers University, Newark, New Jersey 07102)

Abstract

Downside loss-averse preferences have seen a resurgence in the portfolio management literature. This is due to the increasing use of derivatives in managing equity portfolios and the increased use of quantitative techniques for bond portfolio management. We employ the lower partial moment as a risk measure for downside loss aversion and compare mean-variance (M-V) and mean-lower partial moment (M-LPM) optimal portfolios under nonnormal asset return distributions. When asset returns are nearly normally distributed, there is little difference between the optimal M-V and M-LPM portfolios. When asset returns are nonnormal with large left tails, we document significant differences in M-V and M-LPM optimal portfolios. This observation is consistent with industry usage of M-V theory for equity portfolios but not for fixed-income portfolios.

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File URL: http://dx.doi.org/10.1287/mnsc.1050.0486
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Bibliographic Info

Article provided by INFORMS in its journal Management Science.

Volume (Year): 52 (2006)
Issue (Month): 4 (April)
Pages: 558-566

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Handle: RePEc:inm:ormnsc:v:52:y:2006:i:4:p:558-566

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Related research

Keywords: downside risk; loss aversion; portfolio management; lower partial moments; heavy-tail distributions;

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Cited by:
  1. Thomas Gries & Natasa Bilkic, 2014. "Investment under Threat of Disaster," Working Papers CIE 77, University of Paderborn, CIE Center for International Economics.
  2. Bertrand, Philippe & Prigent, Jean-luc, 2011. "Omega performance measure and portfolio insurance," Journal of Banking & Finance, Elsevier, vol. 35(7), pages 1811-1823, July.
  3. Bernard, Carole & Ghossoub, Mario, 2009. "Static Portfolio Choice under Cumulative Prospect Theory," MPRA Paper 15446, University Library of Munich, Germany.
  4. Sévi, Benoît, 2013. "An empirical analysis of the downside risk-return trade-off at daily frequency," Economic Modelling, Elsevier, vol. 31(C), pages 189-197.
  5. repec:dgr:uvatin:2012078 is not listed on IDEAS
  6. Sheng, Jiliang & Wang, Xiaoting & Yang, Jun, 2012. "Incentive contracts in delegated portfolio management under VaR constraint," Economic Modelling, Elsevier, vol. 29(5), pages 1679-1685.
  7. Velu, C. & Iyer, S., 2008. "The Rationality of Irrationality for Managers: Returns- Based Beliefs and the Traveller’s Dilemma," Cambridge Working Papers in Economics 0826, Faculty of Economics, University of Cambridge.
  8. Witt, Rudolf & Waibel, Hermann, 2009. "Lower Partial Moments as a measure of vulnerability to poverty in Cameroon," Hannover Economic Papers (HEP) dp-434, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
  9. Mansourfar, Gholamreza & Mohamad, Shamsher & Hassan, Taufiq, 2010. "The behavior of MENA oil and non-oil producing countries in international portfolio optimization," The Quarterly Review of Economics and Finance, Elsevier, vol. 50(4), pages 415-423, November.
  10. Gabriela Flores & Owen O'Donnell, 2013. "Catastrophic Medical Expenditure Risk," CESifo Working Paper Series 4198, CESifo Group Munich.
  11. Brandouy, Olivier & Kerstens, Kristiaan & Van de Woestyne, Ignace, 2009. "Exploring Bi-Criteria versus Multi-Dimensional Lower Partial Moment Portfolio Models," Working Papers 2009/29, Hogeschool-Universiteit Brussel, Faculteit Economie en Management.
  12. Patrick Leoni, 2007. "Monte-Carlo Estimations of the Downside Risk of Derivative Portfolios," Economics, Finance and Accounting Department Working Paper Series n1760607, Department of Economics, Finance and Accounting, National University of Ireland - Maynooth.
  13. repec:pdn:wpaper:77 is not listed on IDEAS

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